Doubts settle in financial markets
Banking system : the ECB maintains its rates
and injects money
Le Monde,
“Behaviours we observed over the past seven
weeks are identical in many respects to what we saw in 1998, to the stock
market krach of 1987, to the collapse of land prices
in 1837 and to the banking panic of 1907.” Former president of the american Federal reserve system (Fed), Alan Greespan, thus stressed, on the evening of Thusrday September 6, the seriousness of the financial crisis
spawned by default of subprime loans (inordinately
risky loans) in the United States. After several weeks of relent, tensions
abruptly reappeared on financial markets.
This chaotic situation lead the European
Central Bank (ECB), on Thursday, not to raise its rates, contrary to what its
president, Jean-Claude Trichet, had let understand at
the beginning of August. Furthermore the ECB and the Fed injected massive
amounts of money into the banking system in order to avoid “its dislocation”,
to use the word of Mr. Trichet. Banks were reluctant
to lend money to each other, lest they do not get their funds back. This lack
of trust is enhanced by the absence of precise data on exposure of financial
outfits to the “subprime” risk, but also on the
entire set of complex financial products. This opacity is conducive to the appearance
of rumours, like that of the failure of one or several major banks.
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The crisis which unfolded this summer is
lasting. Caused by the failure of a market segment a priori
circumscribed and local, that of subprime mortgage
loans (real estate asset backed loans with a more than normal level of risk) in
the
The market, with was flushed with liquidity,
suddenly dried up. On Thursday September 6, the
“Why doesn’t anybody succeed in finding the
fault? How did we get to this paradoxical situation? There is a lack of
explanations”, observes Philippe Brossard, economist at Euler Hermes. Indeed,
the crisis encompasses a dose of irrationality which seems self-feeding on the
worries of investors.
What is the market afraid of? Investors loathe uncertainty. And
since the beginning of the crisis, they navigate by sight. The world over,
banks invested in securities backed by subprime loans
and are likely to suffer substantial losses. But nobody knows to what extent.
Financial products created via “securitization”,
where subprime loans are employed, are complex. They
often mix these explosive loans with investment grade paper. In fine,
the dangerous products become almost invisible. Moreover, the financial accounting
procedures often enable banks not to record these securities into their balance
sheets [the intermediate banks who “securitized”, i.e. bundled, the mortgage
loans they had extended to risky private individuals, and then sold to other
investors, often hedge funds ; but sometimes these banks retain a partial liability
if the loans default – despite the intricate financial circuits and transfers
of property and therefore liabilities, it boils down to risky loans to bad
debtors, and then the entities which made the loans are exposed, and when they
are large banks, the creditors of these large banks, common households and
firms, are exposed as well, whence possible series of financial failures like falling
rows of dominos. The contemporary medicine, as opposed to that of the early
Thirties, is to inject money into the system to ease credit and prevent
failure, but nobody really knows the potentially adverse consequences of this
temporary injection of money.]. “It is impossible to evaluate losses. The
market discovers them one after the other but does not see the end of the
tunnel”, says René Desfossez, strategist at Natixis. Meanwhile, “financial people are staring at each
other [to try and see who is exposed]”, admits a trader.
Noxious rumours swell. Banks which borrow are
suspected to do it to wipe out subprime losses. Ten
days ago Deutsche Bank thus launched a ten year bond issue. On the 31st
of August, the market feared possible difficulties of Barclays which had
borrowed 1.6 billion pounds (2.36 billion euros) from the Bank of England. On
Wednesday, investors were concerned about the overexposure of Citigroup, the
first bank in the world in terms of stock market capitalisation.
This climate of distrust has an impact on the
inter bank market where banks borrow and loan each other money. The risk
premium currently asked for is unusually high. In
Alan Greenspan, the former president of the US
Federal reserve board (Fed), evoked last Thursday similarities between the
present crisis and that of 1998 (following the collapse of the hedge fund LTCM)
and the stock market krach of 1987. The “old wise
man” even draws a parallel with the crisis caused by the collapse of land
prices in 1837 and the banking panic of 1907!
Are banks threatened by failure? The German banks IKB and Sachsen LB illustrated the seriousness of the crisis. They went
to the brink of failure because of their investments in the
Nonetheless, few analysts imagine that the
world banking system could be under threat. “The risks are probably
overestimated”, deems Cyril Regnat of Natixis. Large banks have accumulated enough profits over
the past years to be able to weather possible losses.
Yet, “the figures one hears of are
frightening”, admits one trader. On Tuesday, a memo from Barclays mentioned 1400
billion dollars (1023 billion euros) worth of financial products which banks might
have to refinance. And as the crisis intensifies, this figure rises.
Can central banks solve the crisis? Monetary authorities can only
“alleviate” the banking system difficulties by offering temporary credit
facilities. Most central banks have “injected” money regularly since the
beginning of August, to the tune of dozens of billions of euros in the monetary
circuits. But these actions are only temporary expedients. The sums poured into
the system are in fact special loans extended to banks, overnight, for a week,
or for three months. And banks already have refunded or will have to refund
these credits. To enhance its impact, the Fed, on the 17th of
August, lowered one of its refinancing rates to banks. To no
avail.
Following the president of the Deutsche Bank,
Joseph Ackermann, Jean-Claude Trichet, the president
of the European Central Banque, declared on Thursday
that “the principal ingredient missing is confidence”. Current worries are “due
for a large part to the lack of sufficient transparency on the risks incurred”
by the banks, he added.
Is the economy in jeopardy? On Thursday, the International
Monetary Fund (IMF) announced that it was revising its forecasts for growth in
2008, lowering them to take into account the impact of the financial crisis.
Until now they were 2.8% for the
The situation of the American economy, which
was already slowing down, is penalised. According the Mortgage Banks
Association (MBA), the number of homes seized back by banks [because the
dwellers, indebted to the banks, defaulted seriously on their payment schedule]
reached a record level during the second quarter in the United States, and more
than 5% of American households have experienced delays in their repayments.
Moreover, 35 000 jobs were cancelled in the financial sector in August.
The Lehman Brothers bank just announced 850 lay-offs.
The subprime crisis
is degenerating into a generalised credit crisis (credit crunch). From firms
which have difficulties financing themselves, to real estate loans and credits
to consumption which may become more expensive, it is the whole system which is
under duress.
Claire Gatinois and Cécile Prudhomme
Translation André Cabannes